Incremental operating cash inflows Strong Tool Company has been considering purc
ID: 2738854 • Letter: I
Question
Incremental operating cash inflowsStrong Tool Company has been considering purchasing a new lathe to replace a fully depreciated lathe that will last 5 more years. The new lathe is expected to have a 5-year life and depreciation charges of $2,320 in Year 1; 3,712 in Year 2; $2,204 in Year 3 $1,392 in both Year 4 and Year 5; and $580 in Year 6 The firm estimates the revenues and expenses (excluding depreciation) for the new and the old lathes to be as shown in the following table the firm is subject to a 40% tax rate on ordinary income.
a. Calculate the operating cash inflows associated with each lathe. (Note: Be sure to consider the depreciation in year 6.)
b. Calculate the incremental (relevant) operating cash inflows resulting from the proposed lathe replacement.
c. Depict on a time line the incremental operating cash inflows calculated in part b.
New Lathe Old Lathe Year Revenue Expenses(excluding depreciation and interest) Revenue Expenses
(excluding depreciation and interest) 1 $38,300 31600 33200 23400 2 $39,300 31600 33200 23400 3 $40,300 31600 33200 23400 4 $41,300 31600 33200 23400 5 $42,300 31600 33200 23400
Explanation / Answer
c) Cash flows on a time line:
0 1 2 3 4 5 6
|.......................|.....................|.....................|....................|......................|.....................|
-932 225 222 497 1097 232
a) OPERATING CASH FLOWS: NEW LATHE: 1 2 3 4 5 revenues 38300 39300 40300 41300 42300 expenses (excl. depreciation and interest) 31600 31600 31600 31600 31600 depreciation 2320 3712 2204 1392 1392 Operating income before tax 4380 3988 6496 8308 9308 tax 2@ 40% 1752 1595.2 2598.4 3323.2 3723.2 Operating income after tax 2628 2392.8 3897.6 4984.8 5584.8 add: depreciation 2320 3712 2204 1392 1392 Operating cash flow 4948 6105 6102 6377 6977 OLD LATHE: 1 2 3 4 5 revenues 33200 33200 33200 33200 33200 expenses (excl. depreciation and interest) 23400 23400 23400 23400 23400 depreciation 0 0 0 0 0 Operating income before tax 9800 9800 9800 9800 9800 tax @ 40% 3920 3920 3920 3920 3920 Operating income after tax 5880 5880 5880 5880 5880 add: depreciation 0 0 0 0 0 Operating cash flow 5880 5880 5880 5880 5880 b) Incremental operating cash flows resulting form the proposed replacement: Operating cash flows of new lathe 4948 6105 6102 6377 6977 Operating cash flows of the old lathe 5880 5880 5880 5880 5880 Incremental cash flows -932 225 222 497 1097